Fast-growing Pace not done yet

As we predicted at the beginning of the year, the recovery at set-top-box manufacturer Pace Group continues to gather speed. Impressive full-year results and a 30% boost to the dividend have cemented a change in sentiment, and the share price is up 9%. The future looks bright, too.

Management celebrated a third consecutive year of turning strong free cash flow into cash profit, up by a quarter to $241 million. With revenue of $2.6 billion, up 6%, pre-tax profit rocketed by over a third to $176 million, giving adjusted EPS of 63.6 cents, up 44% and 12% above JP Morgan’s estimate, largely due to lower than expected financing costs and an unusually low tax rate.

Free cash flow was slightly lower than this time last year at $204 million, 85% of adjusted cash profit instead of 108%. Optimistic management has recommended a final dividend of 4.75 cents per share, giving a full-year payout of 7 cents, 28% higher than last year.

Clearly, the $310 million acquisition of Aurora Networks helped drive profits on lower revenue. While no exact figures were given, JP Morgan reckons the acquisition grew sales by around 10% on a like-for-like basis.

"Aurora Networks has been a great strategic addition to the Pace Group, enabling Pace to widen out into network infrastructure and build deeper, more embedded relationships with our customers," explained Pace boss Mike Pulli. "The integration was achieved ahead of plan and the Networks business achieved a record year due to strong underlying customer demand."

The technology developer for PayTV and broadband services says it has maintained its position as top dog in the PayTV hardware market, but although the division generated record revenue in the second half, it wasn't enough to offset the first-half decline and revenues in the division fell 5% to $2.2 billion. But Pace has managed to drive its diversity plans, with non- consumer premise equipment (CPE) revenue increasing more- than three-fold to $377 million thanks to a strong year for its networks business, which won contracts with Foxtel, TDS Telecom, Frontier Telecom and Viva Broadcast.

"In delivering a 9.2% operating margin we have achieved our mid-term target a year ahead of plan," said Pace. "However, despite the good progress that has been made there remains significant opportunity for the performance of the company to continue to improve. The board are confident that, through Aurora Networks, potential additional acquisitions and the ongoing delivery of our strategic plan, Pace will continue to strengthen its position as a market leading technology solutions provider for the PayTV and broadband industries and deliver further value to our shareholders."

Looking to next year, revenue is expected to reach $2.75 billion, generating $255 million of adjusted cash profit. Pace's ability to generate cash is set to continue, too, with management predicting a range of $185-195 million.

An 8% rally to 363p puts the shares on little more than 8 times JP Morgan's EPS estimates for 2016. "Far too cheap," says the broker, which raises it target price to 457p. It adds:

"Global demand for set-top boxes (STBs) has been resilient through recent difficult economic conditions. The evolution of technology towards hybrid devices and media servers is a development of which Pace is at the forefront. In our opinion, valuation metrics are not stretched if Pace successfully delivers steady improvement in profitability over the medium-term. We remain Overweight."

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.